SECURE 2.0 Tax Credits: An Overview for Employers

The SECURE 2.0 Act has created new and enhanced tax credits for smaller employers that can make it more affordable for them to start a retirement plan. These tax credits may provide a significant benefit for small businesses that are starting a plan.

To qualify for either of the startup tax credits (contribution tax credit and plan cost tax credit), businesses must have:

1. No more than 100 employees who received compensation of $5,000 or more in the preceding year, and
2. The employer didn’t offer a plan covering substantially the same employees during the previous three tax years.

SECURE 2.0 Tax Credit #1: New Employer Contribution Tax Credit

The new employer contribution tax credit follows a scale-down percentage approach. The amount of the credit percentage decreases over a 5-year period. The credit uses a cap on compensation and contribution amounts. The new employer contribution tax credit applied to:

1. Employer contributions allocated to employees that earn no more than $100,000 per year, and
2. Considers only the first $1,000 contributed annually per employee.

Note that this credit applies to defined contribution plans, such as 401(k)'s, that have no more than 100 employees. 

Credit Calculation Based On Plan Size

Plans with 50 or Fewer Employees

The credit percentage for smaller plans with 50 or fewer employees scales down over five years from the effective date of the adoption of the plan. 

Ex1: To illustrate the tax credit and its calculation for plans with 50 employees or less, consider the following:

• A qualified employer has 18 employees.
• The company establishes its first plan, a 401(k) plan, and offers a discretionary Match.
• Of the 18 employees, 16 have compensation less than $100,000 and all earn more than $40,000.
• 12 of those 16 employees defer $5,000 each into the plan.
• The employer contributes a Match equal to 100% of Deferrals not to exceed 15% of compensation (15% of $40K is $6,000, since none defer more than 15% at any compensation level, they all will receive a 100% of Deferral Match, or $5,000).
• Credit Calculation:
  • Employer Match is 100% of Deferrals not to exceed 15% of compensation equals $5,000 in employer Match for each deferring employee;
    • Example: Compensation = $40,000; Deferrals of $5,000 (which is 12.5%); Company Match = 100% of Deferrals ($5,000) not to exceed 15% of Compensation ($6,000); therefore, the Match = $5,000;  
  • Credit Cap is $1,000 Cap for each employee.
  • Total Year 1 Tax Credit is $16,000. (16 X $1,000 = $16,000).

Plans with 51-100 Employees

The tax credit for larger plans, those that have 51 to 100 employees also scales down but there are additional reductions to the credit. 

Ex2: To illustrate the tax credit and its calculation for plans with 51 to 100 employees but no more, consider the following:

• A qualified employer has 78 employees.
• The company establishes its first plan, a 401(k) plan, and offers a discretionary Match.
• Of the 78 employees, 56 have compensation less than $100,000 and all earn more than $40,000.
• 51 of those 56 employees defer $1,500 each into the plan.
• The employer contributes a Match equal to 100% of Deferrals not to exceed 15% of compensation (15% of $40K is $6,000, since none defer more than 15% at any compensation level, they all will receive a 100% of Deferral Match, or $1,500).
• Credit Calculation:
  • Employer Match is 100% of Deferrals not to exceed 15% of compensation equals $1,500 in employer Match for each deferring employee;
    
    • Example: Compensation = $40,000; Deferrals of $1,500 (which is 3.75%); Company Match = 100% of Deferrals ($1,500) not to exceed 15% of Compensation ($6,000); therefore, the Match = $1,500; 
  • 2% Reduction for Each Employee over the 50 limit.
    • 78 employees - 50 employee limit = 28 employees;
    • 28 employees X 2% = 56% Reduction/employee
    • 56% X $1,500 Match = $840 per employee.
  • Total Year 1 Tax Credit is $42,840. (51 X $840 = $42,840).

SECURE 2.0 Tax Credit #2: New Plan Cost Tax Credit

The plan cost tax credit, over the first three (3) tax years commencing with the first year the new plan is effective, reduces the amount of federal taxes that the business may owe. It's important to note that the credit begins with the first year in which the company establishes its first-ever retirement plan.

• 50 or fewer employees: The credit covers 100% of the employer’s ordinary and necessary out-of-pocket plan costs up to an annual limit.
• 51 to 100 employees: The credit covers 50% of the employer’s ordinary and necessary out-of-pocket plan costs up to an annual limit.
• The annual limit is $500 or $250 times (multiplied by) the number of NHCEs, up to $5,000.
• To qualify, the a plan must have at least one participant who is an NHCE, a non-highly compensated employee.
• The credit does not apply to plan costs paid through plan assets or investment expenses. 
• The credit does applies to the costs that the employer has paid to not only set up the plan (one-time expenses) but also to the costs associated with the administration of the plan, these include, but many not be limited to, expenses for:
  • Financial professionals
  • TPA (Uniglobal)
  • Recordkeeping, and
  • Employee education.

It is worth noting that the credits are separate and distinct, and plans may receive one or both credits. If we assume that the employer in our first example, has 16 NHCEs out of the 18 employees, and paid $6,500 for first year setup, recordkeeping, and administration costs, the company could receive an additional credit in the amount of $4,000.

Ex1: Plan Cost Calculation for the 18-Employee Plan
18 Employee; 16 are NHCEs; $6,500 in Year 1 expenses.

• Step 1: Credit Calculation: $6,500 X 100% (less than 50) = $6,500
  
• Step 2: Maximum Credit: $250 X 16 NHCEs = $4,000
• Step 3: Lesser of $6,500 or $4,000 = $4,000 (maximum credit limit by NHCE formula)

This employer, if receiving both credits, would have a total tax credit for Year 1 equal to $20,000 ($16,000 for the contribution credit + $4,000 for the plan cost credit).

Ex2: Plan Cost Calculation for the 78-Employee Plan
78 Employee; 51 are NHCEs; $8,500 in Year 1 expenses.

• Step 1: Credit Calculation: $8,500 X 50% (more than 50) = $4,250
  
• Step 2: Maximum Credit: $250 X 51 NHCEs = $12,750, but capped at $5,000
• Step 3: Lesser of $5,000 or $4,250 = $4,250 (50% of employer costs)

This employer, if receiving both credits, would have a total tax credit for Year 1 equal to $47,090 ($42,840 for the contribution credit + $4,250 for the plan cost credit).

SECURE 2.0 Tax Credit #3: Adding Automatic Enrollment Credit

Under the SECURE 2.0, employers can earn a tax credit for introducing automatic enrollment feature in their plan. This credit amounts to $500 per year for the first three years of inclusion. The eligibility for the credit is limited to employers with no more than 100 employees earning at least $5,000 in compensation in the previous year. The automatic enrollment feature must be structured as an eligible automatic contribution arrangement (EACA), following specific notice requirements, and uniformly apply the plan’s default contribution rate.

The SECURE 2.0 has made this tax credit even more beneficial as certain plans starting after December 29, 2022, are required to use automatic enrollment. Though the requirement will not be effective until 2025, employers with plans that could potentially be subjected to the mandate may consider introducing automatic enrollment during launch to benefit from the tax credit sooner. Even employers with plans not covered under the mandate may add automatic enrollment to take advantage of this credit.

In conclusion, starting a retirement plan has never been better. The SECURE 2.0 Act has made easier for employers to start a plan by adding tax credits. Employers looking to establish a qualified plan can contact us here. We're happy to help!

Disclaimer. A word about assumptions, illustrations, and the content: The information we have is as of December 31, 2022. Other details, rules, and exceptions may apply. This material does not constitute legal or tax advice. For more information, consult your financial professional, legal, or tax advisor. While the examples are hypothetical and provided for illustrative purposes only; they are not intended to represent or predict actual results.